SIE Exam - Products and their risk

If a bond is called at 103.75, how much will an investor receive?

$1,037.50 plus accrued interest

A corporation has a 9% cumulative preferred stock issue outstanding. The company paid a $7 dividend in 2012 and $8 in 2013. If the company wants to pay a common stock dividend in 2014, the cumulative preferred stockholders must first receive a dividend of:

$12 - The cumulative preferred stockholder should receive a yearly dividend of $9. Since it is a cumulative issue, any dividend that is not paid must be made up prior to a common dividend being paid. If a common dividend is to be paid in 2014, the cumulative preferred stockholders must first receive $12 ($2 for 2012 plus $1 for 2013 plus $9 for 2014).

A U.S. Treasury bond is selling in the market at 95.18. The dollar value of this bond is:

$955.62. - U.S. Treasury bonds are quoted in full points and 32nds of a point. A T-bond quote of 95.18 represents 95 18/32. By converting the fraction to a decimal, the quote becomes 95.5625 percent of the par value of $1,000. $1,000 x 95.5625% = $955.62.

A 5% $1,000 par value bond sells at $900 and matures in 10 years. What is the amount of each interest payment?

(.05*1000) = 50 / 2 = $25

Common stock

(1) the basic unit of corporate ownership, (2) the most widely issued type of stock, and (3) the first type of stock that a corporation issues. For bookkeeping purposes, common stock is usually issued with a par (face) value that's an arbitrary amount and is used for the company's financial statement. There's no relationship between the par value of an equity security and its market value.

Bonds: par value

(also referred to as the principal or face value) is the amount that the issuer agrees to pay the investor when the bond matures. Regardless of the amount an investor pays for a bond, if it's held to maturity, the issuer is obligated to pay the par value. Most bonds are issued in multiples of $1,000

two major groups of US issued securities

1. Marketable (negotiable) 2. Non-marketable (non-negotiable)

Which of the following securities is an example of a collateralized time draft? Commercial paper American Depositary Receipts Bankers' acceptances Eurodollars

A BA (banker's acceptance) is used to facilitate foreign trade. It is a time draft that has been guaranteed (collateralized) by a bank.

Bonds: pricing

A bond's price is usually stated as a percentage of its par value. For example, a bond with a price of 100 is selling at 100% of its par value, or $1,000 (100% of $1,000) Traditionally, corporate and municipal bonds trade in increments of 1/8 of a point, while Treasury notes and bonds trade in increments of 1/32 of a point.

Why wouldn't a corporation want to issue convertible bonds?

A disadvantage to convertible bonds is that if all of the bonds are converted into stock, then the number of outstanding shares may increase dramatically.

What's a general obligation (GO) bond?

A general obligation (GO) bond is a type of municipal bond. On a GO bond, the debt service (i.e., interest and principal payments) are paid for by taxes imposed by a municipality.

A grant anticipation note is normally paid from:

A grant anticipation note (GAN) is normally paid from funding provided by the federal government.

A municipality borrowing for a short-term period to finance a capital project would issue:

A municipality borrowing for a short-term period to finance a capital project would issue bond anticipation notes.

American Depositary Receipts (ADRs)

ADRs facilitate the trading of foreign stocks in the United States. An ADR represents a claim to foreign securities while the actual underlying shares are held by U.S. banks located overseas. ADRs trade in U.S. markets, either on an exchange or over-the-counter, and are priced and pay dividends in U.S. dollars, rather than in a foreign currency. ADR shareholders have dividend rights, but don't directly receive preemptive rights (to be covered shortly). can either be sponsored or unsponsored

Bonds: investment grade ratings best to worst

Aaa, Aa, A, (Baa or BBB) For bonds issued by corporations, Moody's further subdivides each major rating category by using a 1, 2, or 3, with 1 being the highest. For example, Aa1 is higher than Aa2, however, Aaa3 is higher than Aa1. Standard & Poor's uses a plus (+) and minus (-) to further distinguish between ratings. For example, A+ is better than A; however, A- is better than BBB+.

Limited liability

Although a corporation is owned by its shareholders, the business is considered a separate person under the law and, therefore, an individual shareholder generally is not held personally responsible for the corporation's debts. If a business fails, the most a shareholder can lose is her original investment

Why do Bond Prices Fluctuate from Par?

Although most bonds are initially sold at par value, as time goes by, these bonds may trade in the market at prices that are less than or more than par. A bond that's sold for less than its par value is selling at a discount, while a bond that's sold for more than its par value is selling at a premium - usually due to the changes in prevailing market interest rates (i.e., interest-rate risk) or concerns about the creditworthiness of the issuer

For an Industrial Development Bond (IDB), the primary source that backs the bond is:

An IDB is issued by a municipality, but secured by a lease agreement with a corporation

The credit rating of a municipality will likely improve with a(n):

An increase in property taxes - results in more funds becoming available to the municipality. As a result, the credit rating of the municipality will likely improve. Decreases in residents and fees being charged for licenses will generally result in a decline in the credit rating. An increase in tolls will provide a benefit to the facility, not the municipality.

What is the order of claim status upon bankruptcy/liquidation?

At liquidation, the corporation's secured creditors receive consideration first, followed by its unsecured creditors, then its preferred stockholders, and the last to receive payments are common stockholders.

What type of securities assist in financing importing and exporting operations?

Bankers' acceptances (BAs)

Who derives the MOST benefit from a put provision attached to a bond offering?

Bondholder - A put provision allows the bondholder to redeem the bond on a specified date (or dates) prior to maturity. This provision is most likely to be utilized if market interest rates rise.

During a period of stable interest rates, which type of preferred stock tends to be the most volatile?

Convertible preferred stock may be converted into a fixed number of common shares of the same issuer. For that reason, if the common stock into which the preferred stock may be converted has appreciated above the parity price, the value of the convertible preferred will also rise. During a period of stable interest rates, the other types of preferred stock tend to remain stable.

A corporate bond that's not backed by any specific asset is referred to as a:

Corporate bonds that are not backed by specific assets of the corporation are referred to as debentures (i.e., unsecured corporate bonds).

Which of the following securities is NOT backed by the credit of the U.S. government? Treasury bills Treasury STRIPS Government National Mortgage Association (GNMA) bonds Federal National Mortgage Association (FNMA) bonds

Federal National Mortgage Association (FNMA) bonds - bonds are issued by a privately owned organization and are not backed by the U.S. government. All of the other choices are directly backed by the U.S. government.

Bonds: Call or convert?

First, determine conversion ratio. This will show # of shares that would be received. Next, determine conversion value by multiplying by MV of stock. If conversion value > then call value then it would be wiser to convert than allow to be called

An investor has purchased a Bristol County General Obligation bond. Which of the following statements is TRUE concerning this investment?

For a general obligation bond (a type of municipal bond), the interest is exempt from federal income tax. In addition, a general obligation bond is backed by the taxing authority of the issuer and the issuer's general promise to repay the debt. In this example, only the taxes that are collected by Bristol County (not the assets of the issuer) are used to back the bonds.

leverage financing

For an issuer, raising capital through debt is referred to as leverage financing since the issuer is borrowing against its net worth. When a corporation has more debt than equity outstanding, it's considered a leveraged issuer

For corporate bonds, accrued interest is calculated based on

For corporate and municipal bonds, accrued interest is calculated based on 30 days in every month and 360 days in the year. On the other hand, Treasury notes and bonds use the actual calendar days in every month and a 365 days in the year

Bonds: Serial versus Term Issues

If all of the bonds in an offering are due to mature on the same date, it's referred to as a term bond issue. On the other hand, if parts of an offering will mature sequentially over several years, it's referred to as a serial bond issue

Bonds: Is Conversion taxable?

If the owners of convertible bonds or convertible preferred stock convert those securities into the common stock of the corporation, the conversion is NOT a taxable event. When these securities are converted, the cost basis for the common stock received will be based on the cost basis of the original security

Bonds: Convertible bonds

In order to offer investors more of an incentive to buy its bonds, a corporation with a weak credit rating may issue convertible bonds. A convertible bond gives an investor the ability to convert the par value of his bond into predetermined number of shares of the company's common stock. For the purchaser, the tradeoff for this opportunity is that convertible issues traditionally offer lower coupons than similar non-convertible issues. If the bonds are converted, the debt becomes equity and the issuers' capital structure will be significantly altered.

An individual is interested in an investment that offers annual income, has the potential of appreciating in value if interest rates decline and, in the event that the issuer fails to make a payment, having the missing amount added to future distributions. For this investor, which type of stock is the most suitable?

Individuals generally purchase preferred stock for income. As with any security that pays a fixed rate, there is the potential for appreciation if interest rates decline. There are several types of preferred stock. Cumulative preferred stock will add all unpaid dividends to a future payment if a cash dividend is to be paid to common shareholders.

Bonds: Interest rate risk

Interest-rate risk implies that as market rates increase, investors will not be interested in purchasing existing bonds at par since they're able to obtain higher yields by purchasing new bonds. Therefore, existing bonds will need to be offered at a discount (put on sale) in order to attract purchasers

What is Moody's lowest rating for a municipal note?

MIG stands for Moody's Investment Grade and refers to ratings given municipal notes. There are three MIG ratings, with the best rating being MIG 1 and the lowest rating being MIG 3.

Bonds: forced conversion

Most convertible issues are callable which provides the issuer with the ability to (at its option) redeem the bonds prior to maturity. However, if the call (redemption) price of the bond is less than the conversion value, the bondholder could be forced to either convert the bond immediately or accept less than its conversion value

The call premium of a bond refers to the amount:

Over par value that the issuer must pay to exercise the call privilege

preferred stock

Preferred stock is often issued by established companies that already have common stock outstanding. These shares are suitable for investors who are more interested in income than capital appreciation (i.e., the same type of investors who might otherwise purchase bonds). Unlike common shares, preferred shares generally lack voting rights. usually issued with a par (face) value of $100, which corresponds to its initial market price, and carries a specified dividend.

A town has started the construction of public sewers. This project is likely paid by a(n):

Public sewers are often built with the proceeds of a special assessment bond. A special assessment is a charge against property that receives a benefit from the improvement.

Rights of common shareholders

Right of inspection Right to vote Right to receive dividends Right to evidence of ownership Right of transfer

Rule 144

Rule 144 regulates the sale of restricted securities and control (affiliated) securities.

Bonds: maturity date

The bond's maturity date is important in determining when an investor will receive her interest payments. One of the payment dates will always be the month and day of maturity, while the other is six months from that date. Therefore, if the investor's 6% corporate bond matures on June 1, 2030, she will receive two payments per year—one every June 1 and the other every December 1

The minimum denomination for negotiable certificates of deposit is:

The minimum denomination for negotiable CDs is $100,000. Typical denominations are often $1,000,000 or more

Bonds: Converting Bonds to Stock

The price at which the bond can be converted is referred to as the conversion price and is set at the time that the bond is issued. To determine the conversion ratio (i.e., the number of shares the investor will receive at conversion), the par value of the bond ($1,000) is divided by the conversion price

The value of the conversion feature on a convertible bond is determined by:

The stock price - Investors will likely convert their bonds if the price of the stock rises or is expected to rise. The other features on a bond (e.g., its maturity date or interest rate) will not have as significant an impact on the value of the conversion feature.

BoYield

The term yield is used in different ways. In some situations, yield may refer to the return on an investment; however, in the case of a debt instrument that's purchased at par value, it refers to the interest payments.

Bonds: calculating yield

There are three different measures for determining a bond's yield—nominal yield (or coupon), the current yield (annual interest ÷ current market price), and yield-to-maturity (effective return).

Bonds: Initial Interest Payment

Traditionally, bonds pay interest on the 1st or 15th of the month to ease paperwork issues. However, newly issued bonds pay interest from the dated date (the date from which interest begins to accrue), which may not fall on the 1st or 15th. the very first coupon on a newly issued bond may be for more or less than the traditional six-month period as the issuer tries to get synchronized with the 1st or 15th payment date. If the first coupon is for more than six months, it's referred to as a long coupon; if the first coupon is for less than six months, it's referred to as a short coupon.

________________ securities are considered the safest type of fixed-income investment and are suitable for the most conservative investors.

Treasury

Which of the treasury securities will provide an investor with protection against purchasing-power risk?

Treasury Inflation-Protected Securities (TIPS) are U.S. government securities that are inflation-adjusted based on the Consumer Price Index (CPI). With TIPS, the rate of interest is fixed. However, the principal amount on which that interest is paid will vary based on the CPI. They are usually purchased as protection against inflationary or purchasing power risk

What type of security is backed by the full faith and credit of the U.S. government and has virtually no credit risk?

Treasury Securities - This "no default" status is the benchmark against which the credit ratings of all other issuers are measured.

A quote of 5.90 - 5.75 is a quote for which security?

Treasury bills - quoted on a discount yield basis while the other choices are quoted at a price. Since yield is inversely related (moves opposite) to price, the higher yield (5.90) represents the lower price and is the bid. The lower yield (5.75) represents the higher price and is the ask (offer).

Which of the treasury securities always trade at a discount?

Treasury bills are issued and trade at discounts since they don't have interest coupons.

T/F: According to the Securities Act of 1933, securities that are issued by the U.S. government (Treasuries) and any government agency are exempt from registration

True

T/F: Securities that are issued by the Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac), which is a government-sponsored enterprise (GSE), are not guaranteed or backed by the U.S. government.

True

T/F: When the conversion ratio is multiplied by the conversion price, the result will always equal par. Therefore, a conversion is immediately profitable if the underlying stock is trading at a premium to the conversion price.

True

A Treasury bond is quoted 105.04 - 105.24. The purchase price that a customer would expect to pay would be:

U.S. Treasury notes and bonds are quoted in 32nds of a point. When purchasing the bond, the customer would pay the offering price of 105.24. To convert 105.24 into a dollar price: Step 1: 105.24 is equal to 105 24/32 Step 2: convert 24/32 into a decimal, which is .75 Step 3: convert 105.75% into a dollar price (105.75% x $1,000 = 1.0575 x $1,000 = $1,057.50) The customer would pay $1,057.50.

What is the ranking of securities from longest to shortest life?

Warrants, options, rights

A type of security that is issued in the U.S. by foreign governments and corporations, trades in U.S. markets, and is denominated in U.S. dollars is called a:

Yankee bonds are issued in the U.S. by foreign corporations and governments, are dollar-denominated securities, and trade in U.S. markets. Yankee bonds are normally issued by foreign entities when conditions in the U.S. are better than in the foreign country.

Bonds: accrued interest

a bondholder who sells a bond between interest payments is usually entitled to the interest earned during the period when he still owned the bond. This accrued interest is the amount of interest that the seller is entitled to receive (from the buyer) and the amount that the buyer is required to pay (to the seller) for a bond being sold in the secondary market.

Bonds: Credit risk

a recognition that an issuer may default and may not be able to meet its obligations to pay interest and principal to the bondholders

statutory voting

a shareholder is given one vote, per share owned, per voting issue. Therefore, the more shares a person owns, the greater her voting power. beneficial for the larger, more substantial (majority) shareholders

Bonds: call provisions

allows the issuer to redeem its outstanding bonds before they reach maturity. If called, the investor receives the full return of principal plus any accrued interest. From the issuer's perspective, the benefit is that it's no longer required to make periodic interest payments once the bond issue has been called. One of the main reasons that issuers make bonds callable is to have the ability to take advantage of declining interest rates. In an effort to entice investors to buy callable bonds, their yields (coupons) are typically higher than those of non-callable bonds

Callable preferred stock

allows the issuer to retire (call) the stock in at a predetermined price.

Participating preferred stock

allows the owners to share in the extraordinary earnings of a company. Essentially, participating preferred has a stated dividend, but these shareholders may receive more than that amount based on the profits of the issuing company (along with common shares) if company profits reach a certain level.

Control securities

are registered securities that are acquired by control (affiliated) persons in the secondary market. Control persons may include officers, directors, or other insiders (those with more than 10% ownership) and their respective family members. Rule 144 reqs: no holding period notice of sale sale volume limitations

Restricted securities

are the unregistered securities that are typically acquired by investors through private placements. rule 144 reqs: holding period (generally 6 months) notice of sale

Raising capital and financing with debt

borrowing money by selling bonds to investors (considered creditors) The funds are borrowed for a predetermined period and the company is required to make interest payments to the bondholders over the life of the bond. Bondholders are not considered owners and therefore they have no voting rights. Returns are limited to the interest that the corporation pays them for the use of their money.

A corporation has raised money to use for expansion of its plant within the next six months. In which of the following securities should the corporation invest the funds until they are used?

commercial paper since it is extremely safe and can be purchased with a short maturity to match the corporation's needs

cumulative voting

cumulative voting, shareholders are able to multiply the number of shares that they own by the number of voting issues. The result of that calculation is the total number of votes that shareholders may cast in any manner that they choose. Cumulative voting tends to favor the smaller, less substantial (minority) shareholders.

If an individual does not subscribe to additional stock in a rights offering, his proportionate ownership interest in the company will ____________.

decrease

Municipal bond rating organizations are concerned primarily with the risk of:

default

The board of directors has control over _________ but must have shareholder approval for a ____________.

dividends, stock split

Bonds: Zero-coupon bonds

don't pay periodic interest. Instead, an investor purchases a zero-coupon at a deep discount from its par value, but redeems the bond for its full face value (lump sum) at maturity. The difference between the purchase price and the amount that the investor receives at maturity is considered the bond's interest. Usually, the longer the zero-coupon bond's maturity, the deeper its discount will be from par value.

XYZ corporation has 7,000,000 shares of common stock ($1 par value) authorized, of which 5,000,000 shares have been issued. There are 500,000 shares of treasury stock. The current market price of XYZ is 20.

found by multiplying the market value by the outstanding shares. $20 market value x 4,500,000 shares outstanding = $90,000,000

Generally, bonds with longer maturities offer ________ coupons

higher - Since the investor's money is at risk for a long period, the investor expects a higher rate of return than those offered by shorter-term investments.

Bonds: Fixed or Variable Rates

in some cases, as interest rates move up or down, the coupon rate will be adjusted to reflect market conditions. These adjustable rate bonds are sometimes referred to as variable or floating rate securities

Raising capital and financing with equity

investors who purchase stock become part owners of the corporation. Since the investors are provided with an ownership interest in the corporation, these securities are referred to as equities. Stockholders do not receive guaranteed interest payments and there's no maturity date on their investments.

Who derives the MOST benefit from a call provision attached to a bond offering?

issuers

American Depository Receipt

may be sponsored by the company whose common stock underlies the ADR, or it may be unsponsored. In a sponsored ADR, the company pays a depositary bank to issue shares in the U.S. Many of the largest ADRs are sponsored. This allows the company to raise capital in the U.S. and list the ADR on the NYSE, or Nasdaq. In an unsponsored ADR, the company does not pay for the cost associated with trading in the U.S. A depositary bank issues the ADR. In an unsponsored ADR, the issue will trade in the OTC market

Bonds: Coupon rate

or stated rate - fixed interest rate that determines interest payments based on the par value of the bond, not the amt paid

Bonds: conversion ratio

par value / conversion price

The certificate which gives a person other than the stockholder the right to vote is referred to as a _________.

proxy

sale volume limitations for controlled persons under rule 144

sale volume limit for a 90-day period is the greater of 1% of the total shares outstanding or the average weekly trading volume during the four weeks preceding the filing

______-term bonds are usually safer investments since buyers know that their money will be returned relatively quickly.

short - For this safety, investors are willing to accept lower rates of interest

Voting methods

statutory and cumulative

unsponsored ADR

the company does not pay for the cost associated with trading in the U.S.; instead, a depository bank issues the ADR. Unsponsored ADRs trade in the OTC market

sponsored ADR

the company whose stock underlies the ADR pays a depositary bank to issue ADR shares in the U.S. This sponsorship permits the company to raise capital in the U.S. and list the ADR on either the NYSE or Nasdaq. Many of the largest ADRs are sponsored.

A bondholder can find the details regarding the terms and features of her bond from the:

the indenture

Outstanding Stock

the number of shares that have been issued to the public, minus any stock that has been repurchased by the company (treasury stock). Outstanding stock receives dividends and has voting rights.

Bonds: prices and yields relationship

there is an inverse relationship that exists between market interest rates and existing bond prices. if interest rates rise, the value (price) of existing bonds will fall since the demand for existing bonds that offer lower interest rates will decline. If interest rates fall, the value (price) of existing bonds will rise since they're worth more than a new bond issued with a lower coupon

Why would a corporation want to issue convertible bonds?

they allow corporations to borrow money at a lower rate (lower coupon) since the convertible feature is attractive to investors. conversion adjusts the mandatory debt obligation into equity and deleverages the corporation's balance sheet. This deleveraging is useful because it removes both the near-term and long-term debt service obligations. Think: dividends are optional but bond interest payments are mandetory

T/F: Bankers' acceptances (BAs) help facilitate foreign trade. ADRs permit the trading of foreign stocks in the U.S.

true

a general obligation bond is backed by the taxing authority of the issuer and the issuer's general promise to repay the debt.

true

market capitalization

what many market professionals refer to indicate its size, which is found by multiplying the current market price of the stock by the number of outstanding shares